8/30/2007 @ 12:00PM

Best Renters' Markets

When bad news comes out of the housing market, skittish potential buyers opt to wait for the market to bottom out. And since they have to live somewhere, these would-be buyers rent.

If you’re looking to rent property–for whatever reason–the best place to try is Atlanta, where rental vacancies are expanding and prices are going up slower than inflation. Not far behind are Denver and Phoenix, where yields and supply problems are giving investors fits, but making life easy for renters.

Much like a buyers’ market in the residential sector, the best renters’ markets occur where supply is abundant, price growth is flat and renters can get the best value for their dollar.

Using data from real estate investment firm Marcus & Millichap, we first ranked 40 of the largest U.S. cities by the year-over-year change in rental prices for Class A, Class B and Class C properties, with Class A being the most luxurious segment of the market.

Then, capitalization rates–the percent of a property’s value acquired in yearly rent–were calculated. The higher the cap rate, the more lucrative it is for investors. The lower the cap rate, the less a renter has to pay to rent a more valuable property.

Next, using data from the Bureau of Labor Statistics, we calculated how much of a resident’s salary goes into rent. In San Francisco, a Class A apartment costs 45% of earnings. In comparison, the top apartments in Atlanta run at 21% of earnings.

Finally, cities were ranked on the relative tightening or loosening of vacancies in the rental sector based on data from the National Association of Realtors (NAR) Commercial Real Estate Outlook. A tightening market indicates a dwindling supply and signals a likely rise in rents, as leasers have more bargaining power than renters.

The Condo Effect

When the housing boom was in full force, building owners looking to cash in on the run-up converted rental units into condos. The resulting dip in supply reduced vacancy rates, especially in markets where the condo market was highly lucrative. Two good examples of this phenomenon are Miami and Las Vegas, which as late as 2006 had among the lowest vacancy rates in the country, according to the National Association of Realtors (NAR).

Normally, when housing prices dip, as they have over the last six quarters in Miami and Las Vegas, the rental market tightens. However, the vacancy rates in both markets have increased over the last year, even as both housing markets have slumped and pushed people back into the renting market.

The reason: the change in the condo market dynamic. Supply has come back into the normal range following the condo-conversion craze, and instead of rental units migrating into the condo market, unsold condos are moving into the rental supply as sellers try to wait out the inventory glut.

Hessam Nadji, director of research services for Marcus & Millichap, says that condos placed on the rental market are usually high-rise luxury condos that only compete with Class A (luxury) apartment rentals. In turn, the increased supply of luxury rentals flattens prices.

Take South Florida. Miami and Tampa are vastly oversupplied in the condo market and both are seeing significant price declines. As a result, luxury condos built to be sold are instead being rented, and damaging luxury rents. In year-over-year terms, Miami’s Class A apartments grew in price by 2.8%, as compared with 5.1% in Class B and Class C. Likewise, Tampa Class A apartments commanded 2.1% more than last year vs. the 4.6% increase in Class B and Class C apartments.

Staying Ahead Of The Game

Markets with affordable housing stock like Atlanta and Phoenix are more prone to swings in the rental market, as renters are more likely to migrate en masse into buying during a market upsurge. Unaffordable housing markets like New York are more likely to be robust from an investment perspective, as the base of renters is less fluid: People stay renters for longer and it’s more difficult for the unqualified to take an ill-informed dip into the buying pool.

But for the time being, as housing inventory continues to soar, the rental market is a great place to be.